If you’re a small business owner, you’ve probably wondered: What is amortization of intangible assets? Besides Goodwill, you might be wondering how to calculate this expense, as well as the importance of amortization for intangible assets. Here are some answers:
Goodwill is a non-monetary asset that lacks physical substance. Its value is determined by its reputation among customers and management, and may be higher than the value of the company’s tangible and identifiable intangible assets. Consequently, the goodwill may be more valuable than the total fair market value of these assets, and it indicates that the company generates a higher income per dollar invested. Although goodwill cannot be sold, transferred, or exchanged, it is worth a lot.
Under the previous GAAP, goodwill is automatically amortized every year, but that is no longer the case. A business must periodically appraise goodwill and record an impairment charge when its current market value falls below its original cost or increases. However, a private company can still choose to amortize goodwill over a 10-year period to minimize the costs and complexity. But before deciding on an amortization period, a company must decide whether it is in its best interest to amortize goodwill.
Intangible assets with a finite useful life
The first step in the amortization of intangible assets is determining whether they have a finite or indefinite useful life. The useful life of an asset is the time during which a company can expect to benefit from it. A company will determine its useful life by periodically evaluating the asset. If the asset’s value has diminished, the company must recognize a loss and credit the intangible assets account.
An example of an amortization of an intangible asset with a finite useful life is patents. A patent may be valuable for 15 years but becomes worthless after five. If a company can expect to use the patent for that long, it should expense it as an intangible asset and amortize it over that time. The amortization expense should be calculated over the useful life of the asset, in years, rather than as a percentage of its original value.
Calculating amortization of intangible assets
The process of depreciation for intangible assets is similar to that for fixed assets. However, amortization of intangible assets does not include the temporary differences that can occur with tangible assets. For accounting and tax purposes, amortization should be done according to the same principle, which is linear. This method can be applied for both fixed and non-fixed assets. To calculate amortization of intangible assets, follow these steps:
To calculate the depreciation of an intangible asset, you should first determine its useful life. For example, a software product might have a four-year useful life. A 25% depreciation rate is used in this case. Then, the depreciation deduction is based on the residual value of the intangible asset at the beginning of the reporting year. The amortization of intangible assets is also calculated according to the method of diminishing balance.
Importance of amortizing intangible assets
Intangible assets are property and rights that have no physical form, but have a high value and can be depreciated over time. Often, they are subject to amortization, allowing a business to write off a portion of the value each year. Moreover, these assets can help a business reduce its tax bill by depreciating over a period of several years. There are six basic ways to amortize intangible assets.
Intangible assets do not have a definite start-up cost, and amortization matches the amount of expense with revenue. For example, an automobile company will amortize a piece of music over four years, then move on to another advertising campaign. Assuming that the music is valued at $1 million, the amortization rate is $250,000 x 12 months. A similar method would result in 48 payments.
In conclusion, amortization of intangible assets is a process that businesses use to track and report the depreciation of their intangible assets. This process is important for businesses because it allows them to keep track of their assets and make sure they are properly accounting for them. It is also important for businesses to understand the amortization process so they can make informed decisions about their intangible assets.